Platform Solution
White Paper
Transaction Based Pricing in BPO:
In Tune with Changing Times
About the Author(s)
Raj Agrawal
Current Designation
Raj heads the Platform Solutions Unit at TCS. In his career spanning over 19 years in TCS,
Raj has played multiple leadership roles in the past – as CRM Practice Head and
Enterprise Solutions Practice Head.
In his current role as Business Unit Head of Platform Solutions in TCS, Raj holds overall
responsibility including P&L responsibility for the unit.
Raj is a Bachelor of Technology in Electrical Engineering from India’s premier technology
institute, the Indian Institute of Technology, Kanpur.
Sudhir Varma
Current Designation
Sudhir has been with TCS for more than 12 years. He has been involved in multiple
business strategy, CRM and IT consulting and implementation assignments for Fortune
1000 clients.
In his current role, Sudhir manages the Pricing function in the Platform Solutions unit
which includes creating transaction based pricing models for offerings and participating
in determination and decision of pricing and commercial terms for bid responses.
Sudhir has a Masters degree in Management and a Bachelors degree in Engineering.
Jay Ludhwani
Current Designation
Jay has been with TCS for 2 years. In his current role as pricing executive with Platform
Solutions unit, he is involved in creating transaction based pricing models for offerings
and participating in determination of pricing and commercial terms for bid responses.
Jay has a Masters degree in Management and a Bachelors degree in Management.
Abstract
With rapid growth of Business Process Outsourcing (BPO) in the past two decades, there is a
need for new pricing models that meet the changing expectations of customers. Initially,
most of the BPO value proposition was built on simple manpower replacement, which led to
widespread use of FTE based pricing model. Increasingly, customers have started looking for
benefits beyond cost savings and service improvements. This has led to emergence of pricing
models like transaction based pricing and outcome based pricing.
This white paper focuses on discussing transaction based pricing model with the aim to make
the reader aware of its suitability in meeting present-day BPO objectives and its superiority
over FTE based pricing model. The white paper covers what, why and how aspects of
transaction based pricing including how it works in practice, which business processes are
suitable for this type of pricing, what challenges are posed by it and how it is superior to FTE
based pricing model.
Contents
1. Background
5
2. Pricing Models for BPO Services
6
3. What is Transaction Based Pricing?
8
4. Is Transaction Based Pricing Suitable for Any Business Process?
10
5. Transaction Based Pricing v/s FTE Based Pricing
12
6. Benefits of Transaction Based Pricing
15
7. Challenges in Adopting Transaction Based Pricing
16
8. Suggestions to Overcome the Challenges
17
9. Conclusion
18
Background
Business Process Outsourcing (BPO) has grown rapidly in the past two decades. This has brought with it increased
level of maturity in the way BPO pricing gets structured. Initially, the BPO pricing was built on simple manpower
replacement which led to a pricing model that compared directly with what it replaced - the cost to the company
per employee. In third-party outsourcing, this meant pricing on the basis of Full-Time-Equivalent (FTE) or FTE
pricing.
Gradually, as outsourcing matured, customers started looking for benefits that went beyond cost savings and
service improvements to providing broader business value and impact. This led to emergence of pricing models
like transaction based pricing and outcome based pricing. These pricing models are more representative of this
change in BPO objectives as they link price to either customer’s usage of service, as in the case of transaction based
pricing model; or to meeting a minimum success criteria or a business outcome, as in the case of outcome based
pricing model.
This white paper focuses on transaction based pricing model for BPO services. It aims to make the reader aware of
its suitability in meeting present-day BPO objectives and its superiority over FTE based pricing model. The white
paper provides an in-depth discussion of the following aspects related to transaction based pricing:
n
What different pricing models are used in BPO?
n
What is transaction based pricing and how does it work?
n
How transaction based pricing compares with FTE pricing?
n
Which business processes are suitable for transaction based pricing?
n
What are the benefits of transaction based pricing?
n
What are the challenges in adopting transaction based pricing?
n
How can these challenges be overcome?
Transaction based pricing is also called by various other names like output based pricing or utility based pricing or
variable pricing or pay-as-you-go pricing or pay-as-you-drink pricing or pay-per-use pricing. For the sake of
consistent understanding, we would use the term ‘transaction based pricing’ in this whitepaper.
5
Pricing Models for BPO Services
The various pricing models that are being used in BPO fall into any one or a combination of the following three
types of pricing models:
Input Based Pricing Model
This refers to a pricing model where payment to service provider is based on an estimated amount of input
provided. In most cases, this input is “manpower”. FTE-based pricing model is the most commonly used input based
pricing model. The price is quoted as an average FTE rate per hour along with the number of FTEs required.
Pros
n
n
Cons
Simple to understand and implement
n
Can be effectively used to compare
price across vendors
n
Does not create incentives for service provider to pursue
efficiency
Not closely related to customer’s business needs or
outcome
Commonly Used When
n Transaction volumes are unknown
n Transaction volumes are not closely tied to service provider’s cost drivers
n Output cannot be defined or isolated to service provider
Transaction Based Pricing Model
This refers to a pricing model where payment to service provider is based on the number of transactions processed
by him. Typically, a base price is provided for a specified volume band, with a negotiated increase or decrease in
price as usage fluctuates around the specified band.
Pros
n Closely tied to customer’s business cycle
n
Enhances visibility into consumption pattern
n
Encourages productivity & efficiency improvement
Cons
n May not be directly tied to customer’s
business outcome
Commonly Used When
n Output can be defined
n Transaction volumes are known and predictable
n Transaction volumes are tied to service provider’s cost drivers
6
Outcome Based Pricing Model
This refers to a pricing model where service provider is paid based on the business result achieved by the customer
through service provider’s contribution, such as a percentage of increased profits or reduced operating expenses.
The mechanisms for paying the service provider vary, but generally payment is made in one lump sum when the
result is achieved; or over a short period of time, so that the provider can recoup its investment in a timely manner.
Pros
n Closely tied to customer’s business outcome
n
Properly aligns customer’s and service
provider’s interest to encourage partnership,
innovation and continuous improvement
Cons
n Difficult to isolate service provider’s contribution
and quantify its impact on outcome
n Service provider’s ability to achieve outcome
may be restricted by customer’s people,
processes, systems, etc.
Commonly Used When
n Desired outcome and accountability can be defined and captured
n Innovation is critical
Input-based
Model
Output-based
Model
Outcome-based
Model
Partner
More
A comparison of these pricing models on outcome, risk and relationship maturity axes is depicted in the figure
below:
Supplier Risk/Reward
Relationship Maturity
Gain Sharing
Vendor
Less
Transactionbased
FTE-based
Uncertain/Undefined
Volume/Outcome
Certain/Defined
7
What is Transaction Based Pricing?
Before discussing transaction based pricing, it is important to understand the following terms:Transaction - is a sequence of steps with defined input and output, which achieves a business purpose. In other
words, it is another name for business process or sub-process. Examples of transaction include payroll processing,
invoice processing, etc.
Transaction Unit - is a unit of measure with which a transaction can be objectively measured. Examples of
transaction unit are ‘per payslip’ for payroll processing transaction, ‘per invoice’ for invoice processing transaction,
‘per purchase order’ for purchase order processing transaction.
Transaction based pricing refers to a type of pricing where a deal is priced on the basis of number of transactions
that service provider processes for a customer. More the number of transactions processed by service provider,
more is the payment and vice versa. It is similar to the way payment is made by consumers to electricity companies
- amount paid varies depending upon consumer’s usage of electricity, measured in units.
Since, in transaction based pricing, service provider is paid on the basis of number of transactions processed, it is
important to determine the mechanism by which transactions can be distinctly determined and objectively
measured. This is typically achieved via ‘transaction unit’. Determining the right transaction unit, therefore, is
important in transaction based pricing. Transaction unit is usually determined by identifying the unit that best
represents the underlying transaction - in terms of operational processing and the costs related with processing
that transaction.
In transaction based pricing, what and how many resources are involved and how much time is taken to process
the transaction while also meeting quality and service level agreement (SLA) requirements, are the variables that
are typically managed by service provider. This essentially means that variability and risk associated with customer’s
business activity is transferred to service provider. Service provider manages this risk by utilizing resources
efficiently across multiple customers and by charging an appropriate risk premium in the transaction price. In
addition, service provider is motivated to maximize output or number of transactions processed with same or lesser
input, which typically leads to innovation and better use of technology resulting in lesser cost for customer in the
ultimate analysis.
Transaction price is typically quoted as “price per transaction unit”. For example, for payroll processing, the
transaction price may be quoted as “x dollars per payslip”; or for invoice processing, the transaction price may be
quoted as “y dollars per invoice”. However, since business activity does not remain at a constant level throughout,
there needs to be a mechanism which can determine how the transaction price varies for different levels of
business activity.
8
To address this, transaction price is generally mentioned as applicable for a specified transaction volume range.
Such a volume range is known as ‘dead band’ which is typically derived by analyzing historical transaction volumes
data. For variations in transaction volumes beyond the dead band, a negotiated increase or decrease in price
becomes applicable. Usually ARC/RRC (Additional Resource Charge/Reduced Resource Credit) framework is used to
arrive at the price outside the dead band. A simplified explanation of the ARC/RRC mechanism is provided with the
help of an example below:
Example:
Let us assume that:
Transaction Price is $4 per unit
Base Volume is 20,000 units
For variation within +/- 10% of the base volume, there is no change in price
For variations > 10% and < 20% from the base volume, the ARC/RRC price is $3.5
With this, let us see how the effective price payable by the customer changes with change in volume. The effective
price is calculated using the following formula:
Effective Price = [(Base Volume X Transaction Price) + (Incremental Volume X ARC/RRC Price)] / Total Volume
Month
Volume
Transaction Price Calculation
Effective Transaction Price
Month 1
20,000
(20,000 X $4)/20,000
$4
Month 2
22,000
(22,000 X $4)/22,000
$4
Month 3
18,000
(18,000 X $4)/18,000
$4
Month 4
24,000
(20,000 X $4 + 4000 X $3.5)/24,000
$3.92
Month 5
16,000
(20,000 X $4 - 4000 X $3.5)/16,000
$4.13
Month 6
23,000
(20,000 X $4 + 3000 X $3.5)/23,000
$3.94
9
As can be seen in the graph below, for months 1, 2 & 3 when volume is within +/-10% of the base volume, effective
price per unit remains $4. In months 4, 5 and 6, when volume variation is more than +/- 10% from the base volume,
transaction price is applicable for the base volume and ARC/RRC price is applicable for volume above/below the
base volume. Hence, effective price for months 4, 5 and 6 is different from the transaction price of $4 per unit - it is
more when volumes are less and less when volumes are more.
30,000
28,000
Excess
Volume
26,000
Volume
within Band
Volume Units
24,000
}
22,000
}}
20,000
18,000
16,000
ARC
($ 3.50)
Dead-band Rage
($ 4.00)
RRC
($ 3.50)
Reduced
Volume
14,000
12,000
10,000
1
2
3
4
5
6
Month
Is Transaction Based Pricing Suitable for Any Business
Process?
From customer’s perspective, transaction based pricing is favored for business processes which can be clearly
defined, measured in discrete units, have a well defined and measurable service level requirement (which remains
stable even if number of transactions or users fluctuate), have fairly accurate baselines and experience fluctuations
in consumption.
From service provider’s perspective, the ability to deliver profitably in transaction based pricing scenario is tied to
achieving volume and scale. Therefore, this type of pricing is usually favored for business processes that are
standardized, transaction-intensive and demand-driven.
10
In practice, therefore, transaction based pricing is suitable for business processes or transactions that have the
following characteristics:
Me
Characteristics
of
Business
Process
as
ur
ab
le
Volu
m
Driv e
en
and
Dem bility
ia
Var
ll
We ned
i
f
De
Standardized
n
Well Defined: Transaction should be such that both service provider and customer understand what it
constitutes and what is excluded from it.
n
Measurable: Transaction should be such that it can be easily measured for operations processing and
performance and is auditable by service provider and customer for accurate and timely counting of transactions
that serve as the basis for billing.
n
Volume Driven: Transaction should be of short duration and is carried out repeatedly in sufficiently large
volumes.
n
Standardized: Transaction should be amenable to high level of standardization - standard inputs, rule-based
processing and standard output - so that service provider is able to drive economies-of-scale via automation and
delivery of similar services to multiple customers.
n
Demand Variability: Transactions where volumes vary in a short span of time are more suited to be priced via
transaction pricing mechanism than via any input-based mechanism.
11
An indicative list of business processes (with commonly used transaction units) that possess the above-mentioned
characteristics and are, therefore, amenable to transaction based pricing, is provided below:
Function / Vertical
Human
Resource
Management
Business Process
n Payroll Processing
n Recruitment
n Travel Planning
n Expense Management
n
n
Finance & Accounting
n
n
n
Mortgage
n
n
n
n
Insurance
n
n
n
General Accounting
Accounts Payable
Accounts Receivables
Fixed Assets
Transaction Unit
n payslip
n recruit
n booked trip
n expense report
n
n
n
n
Lead Generation
Loan Processing
Loan Servicing
Collection
n
Policy Issuance
Claims processing
Billing/payment processing
Collection
n
n
n
n
n
n
n
journal or chart of account entry
invoice
invoice, % of collection
fixed asset line item
lead
loan application
loan
% of collection, invoice
policy issued/underwritten, quote
claim
invoice
% of collection
Transaction Based Pricing v/s FTE Based Pricing
Having discussed transaction based pricing, let us see how it compares with FTE based pricing. The example below
discusses the price that customer is required to pay under both the pricing models. While doing so, it also
highlights the key differences between these models and their implications – on operational, business and financial
fronts - for customers and service providers.
Example: The customer has outsourced ‘Accounts Payables’ process to a service provider. Based on the data
available for the past few months, invoice volume expected to be processed per month is ~25,000.
12
FTE Pricing:
The service provider has quoted $12.5 per hour per FTE and has estimated approximately 50 FTEs to perform the
work. Assuming that service provider bills customer for 8 hours per day and for 20 days in a month, the customer
would pay an amount equal to $100,000 every month.
From customer’s perspective, the low hourly rate makes it a compelling option. However, the capacity to process
invoices would remain at 25,000 per month. If the volume is less than 25,000 invoices, as in months 3, 4 and 5 in the
figure below, customer will still have to pay this amount to the service provider. In case, it is more than 25,000
invoices, as in months 2 and 6, customer would either face diminished service levels or would have to provide
sufficient time to service provider to scale up the resources. This invariably leads to unfavorable impact on
customer’s business.
140000
Lost Opportunities
Billing (USD)
120000
Staffing Level
Wastage
100000
80000
60000
40000
20000
0
1
2
3
4
5
6
Month
Also, customers normally expect service providers to improve productivity and efficiency beyond year-on-year
productivity improvements that service providers typically agree for in contracts. This is because customers expect
service providers to bring in the much needed automation to facilitate faster processing of tasks and pass on
productivity and efficiency related gains. But, from service provider’s perspective, there is no real incentive to
improve productivity and efficiency beyond what is agreed in the contract. This is because any such efficiency
improvement would mean reduced requirement of FTEs and since the pricing model is based on the number of
FTEs, this would mean reduced revenue for service provider.
13
Transaction Pricing:
Service provider has quoted $4 as the transaction price for each invoice processed. Invoice volume expected to be
processed per month is ~25,000 and there is no change in price for volume variation within +/- 30% of invoice
volume.
From customer’s perspective, this is an attractive option because all the risk related to increase or decrease in
volume of transactions is borne by service provider. For the months when transaction volume is more than 25,000,
the service provider would put in extra resources to meet the service levels. For the months when transaction
volume is less than 25,000, the service provider utilizes extra resources for another customer. The customer,
therefore, pays service provider only for the transactions processed in a given month.
140000
Billing (USD)
120000
Staffing Level
100000
80000
60000
40000
20000
0
1
2
3
4
5
6
Month
Let us see the cost that the customer incurs in different months for the above two options:
Month Invoice Volume Customer’s Cost in $ (FTE Pricing) Customer’s Cost in $ (Transaction Pricing)
1
25,000
100,000
100,000
2
29,000
100,000
116,000
3
17,500
100,000
70,000
4
18,000
100,000
72,000
5
20,000
100,000
80,000
6
27,000
100,000
108,000
Total
136,500
600,000
546,000
14
The additional cost that customer incurs in transaction pricing model in months 2 and 6, should be weighed
against opportunity loss or diminished service levels that customer would face in FTE pricing option. Invariably, the
cost of opportunity loss or diminished service level would more than outweigh the additional cost that customer
pays in transaction pricing model.
Therefore, in the overall analysis as depicted below, transaction based pricing turns out to be more cost effective as
it leads to additional savings - as a result of improved efficiency of operations and avoidance of opportunity loss beyond labor arbitrage gains.
}
y%
additional
savings due
to transaction
pricing
Cost
}
x% cost
savings
due to
labour
arbitrage
Inhouse Costs
Costs - FTE Pricing
Costs - Transaction Pricing
Benefits of Transaction Based Pricing
The preceding discussion brings to the fore some of the benefits of transaction based pricing vis-à-vis FTE based
pricing. Apart from these, some of the other significant benefits that this pricing model provides to customers as
well as service providers are discussed below:
n
From customer’s perspective, the benefits of transaction based pricing are:
n
More flexible and scalable pricing model as payment is for consumption only
n
Effective monitoring of costs due to enhanced visibility into consumption pattern
n
Lower per unit cost due to improved efficiency
n
Makes it easy to compare and select service providers by comparing their per transaction price along with SLAs
15
From service provider’s perspective, the benefits of transaction based pricing are:
n
Improve profit margin by charging more for value created and higher risk owned
n
Better control of service delivery as people ramp up/down and re-allocation becomes easy
n
Offer commercial differentiation (higher savings) due to standardization and innovations that result in higher
output for lesser input
Challenges in Adopting Transaction Based Pricing
While, there are significant benefits from transaction based pricing for customers and service providers both, there
are a few challenges, discussed below, that one needs to be aware of:
n
Complexity: Designing transaction based pricing model is complex and requires a good understanding of
transactions and their cost structure by both customers and service providers - right transaction, scope, unit of
measure, cost determination, etc.
n
Predicting Volumes: Predicting future transaction volumes with reasonable level of accuracy, providing
minimum volume commitment for economies-of-scale and planning for volume variations is a complicated
exercise that only a few customers are able to perform in a systematic and consistent manner.
n
Lack of Availability of Benchmarking Data: Lack of availability of reliable external benchmarks, in addition to
unreliable internal benchmarks, hamper customers’ ability to ascertain commercial competitiveness of service
provider quotes.
n
Lack of Standardization: Lack of common technology and operational business processes within customer
organization limits service providers’ ability to achieve standardization and associated cost effectiveness.
n
Loss of Control: Since day-to-day resource decisions and productivity information are not apparent to the
customer, there is a perception that transaction based pricing leads to loss of control.
n
Organization Change: Transaction based pricing leads to changes in quite a few areas like budgeting (tracking
inconsistent monthly/quarterly service cost); corporate finance (ensuring that invoices reflect accurate charges
and credits); functional departments (effecting business process change); all departments (inculcating demand
forecasting practices).
16
Suggestions to Overcome the Challenges
While some challenges are real, others are more a matter of perception. However, both can be addressed by
ensuring a collaborative effort from service provider as well as customer. Some suggestions in this direction are
indicated below:
n
Choose the right transaction unit for pricing the deal – one that aligns both parties’ interests. For example, in
case of insurance, if the transaction unit is ‘no. of policies issued’, then the interest of service provider and
customer are aligned - more the number of policies issued, more is the payment to service provider and more is
the premium collected by the customer. As against this, if the transaction unit is ‘no. of leads’, then the interest of
the customer and service provider are not necessarily aligned as more number of leads would definitely
translate into more payment for service provider but may not translate into more policies issued and thereby,
premium, for customer.
n
Establish a mutually agreeable mechanism to address volume fluctuations. A few such mechanisms could be:
n
Define an ARC/RRC framework to handle volume variations beyond the base volume
n
Adjust the baseline volume periodically using average volume experienced in the past few months thus
allowing both parties to share the risk of volume uncertainty and allowing service provider sufficient lead
time to absorb volume fluctuations
n
Agree for less stringent service levels for service provider if actual volumes materially exceed those
forecasted
n
Agree on defining and measuring SLAs during the initial phases of the engagement and use this data for base
lining them for the remaining term of the engagement
n
Plan for a comprehensive change management effort which includes top management support, syndication of
key stakeholders and end-user education programs
n
Exercise high level of transparency in sharing data and details between the parties to develop an environment of
trust
17
Conclusion
It is essential to decide which pricing model should be used in structuring BPO deals. Customer will always look for
capital investment avoidance, minimum risk, high quality of service at a low price, maximum price flexibility and
transparency. On the other hand, service provider will look for minimum operational and financial risk, consistent
and predictable profit and revenue growth, longest contract term possible and commercial viability. An effective
pricing model would be one that helps in aligning the interests of customer and service provider. It should help in
arriving at a price that is competitive yet profitable, flexible, simple and easy to apply, representative of business
realities and maximizes benefits for both the parties.
Given the right business processes and proper design, transaction based pricing offers significant benefits to
customers. It is inherently flexible, as cost to customer over a period of time, can fluctuate without any need to renegotiate commercial terms. It also encourages innovation by service provider because, the more efficiently he can
provide service per unit, the more profitable providing those services becomes. Hence, it enables alignment
between customer and service provider by ensuring that both parties act in the interest of the partnership.
As BPO environment matures and increasingly shifts to “managed services”, BPO services would get bundled and
transaction based pricing model would find more favor with customers than FTE based pricing model. With better
understanding of how transaction pricing works and appreciation of how it benefits both parties, some of the
challenges in transaction based pricing can be resolved by ensuring closer cooperation between customer and
service provider and effective change management. Other challenges would reduce considerably as players gain
maturity and experience from increased adoption of this pricing model. Wider adoption of transaction based
pricing would ultimately lead to overall cost reduction, greater efficiencies due to standardization and
improvement in service levels.
It, therefore, becomes imperative for customers and service providers to adopt transaction based pricing in right
earnest. Charles Darwin once said “It is not the strongest of the species that survives, or the most intelligent. It is the
one that is most adaptable to change.” The time to change BPO pricing model from FTE based pricing to transaction
based pricing, is now.
18
About TCS Platform Solutions
TCS has been one of the earliest providers of Business Process as a Service (BPaaS) cloud solutions
that combine business process services, applications, and infrastructure. Our platform solutions help
large and mid-sized enterprises worldwide achieve greater efficiencies, standardized processes, and
improved performance on business metrics and service level agreements (SLAs).
We provide solutions for Human Capital Management (HCM), Accounts Payable (AP), Finance &
Accounting (F&A), and Analytics. The solutions are hosted on reliable, scalable, and secure
infrastructure.
We deliver transformational value through standardization and consolidation of fragmented global
processes. Our clients benefit from faster time to market and lower upfront investment as well as
total cost of ownership.
Contact
For more information about TCS’ Platform Solutions, contact
platform.solutions@tcs.com
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